Financial System Trials Tribulations Starting Early 2008.

¶ … financial system trials tribulations starting early 2008. Indicate major reasons contributed financial market's collapse. Please leave a space reason. -College Level paperOrder ID

Five major factors that contributed to the financial market's collapse

Reason 1: Historically low interest rates

The first major contributor to the collapse of the worlds' financial markets was the housing bubble. The Federal Reserve dropped interest rates to historically levels after the September 11 terrorist attacks and the dot.com bubble burst. This was to generate more spending and borrowing and propel the nation out of recession. Low interest rates encouraged people to buy on credit. Many people took out mortgages, thinking that this was a good time to buy a house, and many others took out mortgages hoping to 'flip' a house, or sell it for more than they paid for it, as they were convinced that it was impossible for housing prices to go down ("The reasons behind the global economic crisis," Fair Loan Rate, 2008).

Reason 2: The growth of the subprime mortgage market

The subprime mortgage market increased exponentially after the drop in interest rates. Many of these loans were adjustable rate mortgages, and as interest rates increased, more and more consumers defaulted. Some consumers did not fully understand the mortgage instruments they were purchasing, and brokers, eager to cash in on the boom, often pressured people to make potentially ill-advised decisions. Eventually, the housing market began to dry up, as more and more houses stood unsold. When people could not sell their homes and banks could not extend more mortgages, adjustable rate mortgages increased, and more and more people could not pay what they owed on their homes.

Reason 3: The growth of creative financial instruments

Banks bundled the bad loans into collateralized debt obligations and sold these bundles as 'safe' investments. "Rating agencies were paid to rate these products (risking a conflict of interest) and invariably got good ratings, encouraging people to take them up… Banks borrowed even more money to lend out so they could create more securitization" (Shah 2010). To sell more securities, banks made even more loans to subprime lenders.

Reason 4: Credit default swaps and the derivatives market

Credit default swaps, or the insurance taken out on risky loans were also bundled and served to accelerate the rate of the crisis "once the subprime mortgage collapsed, because of the interlinked investments" (Shah 2010). The derivatives market was notoriously lacking in transparency, and many people had no idea they were invested in such a potentially risky venture.